Gold has shined brightly in 2024, delivering remarkable performance alongside other asset classes. Currently trading near record highs, gold’s rise is particularly intriguing given that equity indices are also flirting with historic peaks. So, what’s fueling this upward momentum?
Demand for gold is often driven by various factors, such as inflation concerns, a weaker USD, and periods of financial or geopolitical uncertainty.
However, two new catalysts have recently emerged, propelling demand to greater heights.
This week, we’ll explore these factors, uncover why gold miners don’t always mirror gold’s price movements, and share ways to gain exposure to this precious metal in a manner that fits your investment style.
🏦 Central Banks Are Stacking Gold
Why has gold been in such high demand lately?
A significant factor is central bank buying, which has surged to record levels since 2021. During the 1990s and early 2000s, central banks were net sellers of gold. This trend reversed after the global financial crisis, with significant buying resuming in the last decade.
- 2022: Central banks purchased a record 1,082 tonnes of gold.
- 2023: The trend continued, with 1,037 tonnes added to reserves.
This sustained buying spree underscores gold’s enduring appeal as a hedge against economic and geopolitical uncertainties.
Central banks often purchase gold to diversify their reserves, reduce heavy reliance on the USD, strengthen their balance sheets, and acquire an asset free of credit risk.
A survey conducted by the World Gold Council last year revealed that central banks value gold for its historical significance, ability to preserve value, and resilience during crises. These factors were highlighted as critical motivations for including gold in their reserves.
Outside the realm of central banks, analysts like Nick Colas from DataTrek Research suggest that rising gold demand stems from the US’s strategic use of the USD as a geopolitical tool.
Although the USD remains the dominant reserve currency, actions such as US sanctions on Russia following its Ukraine invasion exposed the vulnerability of dollar accounts, which can be frozen.
✨ Foreign central banks generally store their USD reserves in US banks, granting the US control over these reserves. By converting USD into gold, central banks gain custody of a tangible asset still tied to USD but beyond the direct reach of US influence.
Reallocating USD reserves to gold offers a practical safeguard for nations concerned about potential future conflicts with the US. As geopolitical divisions persist, gold’s appeal is expected to grow.
The same World Gold Council survey supports this view, with 70% of central banks surveyed in May 2023 indicating plans to increase their gold reserves within the next 12 months.
Retail Investors in China and Emerging Markets
For years, real estate was the go-to investment for many Chinese investors. However, this trend has shifted recently. China’s stock market, already perceived as unpredictable and risky, has fallen out of favor over the last two years.
Today, with ongoing crises impacting both the real estate sector and stock market, Chinese investors are exploring alternative investment options for their capital. Gold has emerged as a popular choice, becoming a preferred asset for the average Chinese investor.
Similarly, gold remains a favored store of value in other regions, including India, the Middle East, and various emerging markets. The country’s robust economic growth in India has fueled gold demand, especially during the wedding season when gold jewelry holds cultural significance.
With these strong tailwinds driving demand for gold, it might seem logical that gold mining companies would also thrive. But is that really the case?
Why Aren’t Gold Stocks Keeping Up with Gold Prices?
Gold stocks are often marketed as offering leveraged exposure to changes in gold prices. For example, if a company costs $1,500 to mine an ounce of gold and the market price increases from $2,000 to $2,100, its profit margin jumps from $500 to $600 per ounce—a 5% price increase, resulting in a 20% profit boost. Sounds great in theory, right?
Unfortunately, the reality tells a different story. Gold miners have struggled to grow their earnings at the same pace as rising gold prices and exceed them. A clear example is Barrick Gold, one of the largest gold producers globally, which has faced challenges turning significant profits over the past decade, even as gold prices surged by about 80%.
Share prices have mirrored these challenges. Both the VanEck Gold Miners ETF and the VanEck Junior Gold Miners ETF have significantly lagged behind the SPDR Gold Trust, underperforming it by almost 200% since 2008.
Several factors have contributed to diminishing profits for gold producers:
Depletion of Easy-to-Reach, High-Grade Deposits
The readily accessible, high-quality gold deposits have already been mined, and now, whether producers are working with lower-grade deposits or digging more deeply, the process becomes increasingly costly. For instance, AngloGold Ashanti’s Mponeng gold mine in South Africa reaches nearly 4 km deep. Regardless of the approach, accessing gold becomes more expensive, which reduces profit margins.
Rising Input Costs
Costs for essential resources like labor, energy, and transportation have surged due to higher-than-average inflation. In some regions, gold miners must pay royalties based on a percentage of their earnings, and these royalty payments have been rising globally, especially in countries with less economic stability.
Increased Focus on Safety
While it benefits workers and the industry, heightened safety standards have increased mining costs as producers implement safer practices.
Environmental Concerns Impacting Costs
The growing emphasis on reducing mining’s environmental impact has led to increased operational expenses, particularly related to sustainable practices.
In the past, miners often hedged or forward-sold their production, which limited potential profits. However, most gold producers have reduced or eliminated hedging in the last decade.
Since 2013, gold producers have reported All-In Sustaining Costs (AISC) instead of just cash costs. Previously, only the costs directly related to extracting, processing, and delivering gold were considered, which didn’t offer a complete picture. AISC, on the other hand, accounts for the entire life cycle of a mine, including exploration and capital expenditures, offering a clearer view of profitability.
AISC provides investors with a more accurate reflection of a mine’s financial performance, revealing that profitability has not been as strong as previously thought. This has led to a decline in market interest in the sector, though this may be an overreaction.
Insight: The Cyclical Nature of Gold Stocks
The fact that investors have soured on gold stocks doesn’t mean this trend will last forever.
Like any business, gold producers profit when they sell their product for more than it costs. With little investor interest, this could present an opportunity to buy shares at lower prices if sentiment is overly pessimistic.
As Warren Buffett says, “Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can’t buy what is popular and do well.”
Like energy stocks were unpopular in 2020 and 2021 but saw significant returns in 2022, those who invested then likely saw profitable results. However, investing in energy stocks in 2022, when they were in the spotlight, may have led to losses in 2023 as the sector became overhyped.
The Key Factor: Gold Price Outlook
While production costs are likely to continue rising, if gold prices rise faster, miners can generate solid returns for their shareholders.
Various macroeconomic factors suggest a higher gold price, and some analysts even predict that prices could exceed $3,000 per ounce by the end of next year. This scenario would benefit some gold miners more than others.
Here’s how AISC costs for gold miners have evolved over 2022 and 2023.
If you’re considering gaining exposure to gold, several options are available. Here are a few simple choices:
Gold Mining Stocks
Investing in gold miners could be an option for those seeking a more leveraged approach. However, this comes with added risks as it depends on the company’s ability to manage the complexities of mining operations. The upside potential is typically more significant because the price of gold multiplies mining companies’ revenues.
Physical Gold ETFs
For a more stable approach, consider several physical gold ETFs, such as GLD (SPDR Gold Shares), IAU (iShares Gold Trust), and GLDM (Gold MiniShares Trust). These ETFs own physical gold stored in vaults, eliminating the operational risks that gold miners face.
Buy Physical Gold Yourself
Buying physical gold like bars or coins is another option if you prefer direct ownership. This can offer peace of mind, as you can see your investment firsthand. However, it has drawbacks like reduced liquidity, divisibility, and portability compared to the abovementioned investment vehicles.
Depending on your financial goals and risk tolerance, you can opt for one or combine all three approaches.
Here’s a list of U.S. precious metals firms with strong growth potential and solid financials for those interested in individual companies.
